Ideal Taxes Association

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 Richmans' Trade and Taxes Blog

Not "Free Trade". Let's Have Balanced Trade
Raymond Richman, 11/12/2010

We have been great admirers of Prof. Walter Williams who was for a long time Professor of Economics at George Mason University. He is an admirer of Prof. Milton Friedman and so am I. Friedman was my dissertation advisor. One of the areas where I disagreed with him was in his embrace of free trade as a policy to be pursued by a government unilaterally. There is in my opinion no economic theory that justifies a policy of free trade when your trading partners are practicing mercantilism, a policy of imposing barriers to imports and subsidizing exports.

A policy of free trade can only be justified when both labor and capital and goods can move freely between trading partners. Thanks to the U.S. Constitution we have free trade between the States of the Union. And even so, States compete with one another to attract investors, offering inducements of one sort or another. There is no such thing as free trade between nations. Yet American economists are almost unanimous in encouraging the U.S. to pursue a policy of free trade. The consequences have been tragic for American industrial workers. Prof. William in an opinion piece entitled “Worry Over Trade Deficits” on November 20 which echoes the predominant economic point of view.

He writes:

At the recent Group of 20 (G 20) meeting [of finance ministers)] U.S. Treasury Secretary Timothy F. Geithner called upon the largest industrialized economies to get their current account balance — whether a surplus or a deficit — below 4 percent of their gross domestic product by 2015…. Our annual trade deficit of $500 billion is less than 4 percent of our GDP.

We do not know how Geithner arrived at four percent. In 2008, the U.S. current account deficit was $670 billion, which was 4.67 percent of 2008 GDP. We estimate that it would take 6.7 million U.S. workers to produce $670 billion of manufactured and industrial goods. Prof. Williams apparently does not believe 6.7 million workers losing their jobs is too big a price to pay for free trade in a world dominated by mercantilist policies.

But my disagreement is with his economics.

“Acting on behalf of various interest groups, politicians fret over trade deficits but is it something that ordinary Americans ought to worry about?” Where has Prof. Williams been? – we have 14 million unemployed and American manufacturing is in decline. Just last month, we lost 9000 manufacturing jobs and we are supposed to be on the way to recovery.

He writes:

There's another account called the capital account. It consists of foreign direct investment in the U.S. such as the purchase or construction of machinery, buildings or even whole manufacturing plants plus foreign purchases of stocks, bonds and currencies.

Here he is confusing apples and oranges. Building a manufacturing plant here requires the employment of U.S. resources. It has the same effect as importing those goods and services from us, and should be counted as our exports. That is good but buying stocks, bonds, and building up dollar reserves requires no American labor and materials. It contributes nothing to our economy  that is not already there.    

It would be wonderful if … foreign producers just treasured dollars and simply stored them. We'd be on easy street having a few Americans printing up dollars whilst the rest of the world sends us cars, computers, coffee and other goods in exchange for them.

No, we would not. What happened to the Americans who had been producing cars, computers, and other goods. They lost their jobs and had to look for jobs in the service sector which paid less and lowered the general level of wages in the U.S. Andy Groves, a founder of Intel and its former CEO, says the outsourcing of jobs by our high-tech firms is a disaster for the U.S. and he points out that Apple, HP, Dell, and many others have ten times as many employees producing their goods abroad than they have at home and must bear responsibility for America’s manufacturing decline. But not their profits(!) which grew because it costs less to produce products in China and we do not tax them when they are imported. They are not really American companies; they are Chinese.

Prof. Williams asks:

Here's my question to you: "Have Americans been made worse off because of the current account trade deficit?” I'd answer no. With the dollars foreigners earn selling us goods, they purchase U.S. stocks, bonds and real estate. As a people, we should be proud to be a nation in which millions of people around the world want to buy into.

We answer “YES” we have been made worse off. We gain nothing as a nation when foreigners buy our stock, bonds, and real estate..We would be much better off if foreigners bought American made products. That should make us proud, not the purchase of our stocks, bonds, and real estate. The norm should be balanced trade? What is the purpose of trade anyway? It is to exchange a bundle of goods each country values less for a bundle of goods each country values more. Every example in American textbooks on international trade shows the benefits of trade even when countries impose barriers as long as trade is in balance.

We do not advocate tariffs on specific goods, so-called protective tariffs. What we advocate is what we have called a “scaled tariff”, a tariff that applies to all the imports from a trading partner who has a large chronic trade surplus with us and which is based on the size of our trade deficit with the tariff rate varying, an increase in the rate if the trade deficit increases and a reduction in the tariff as the trade balance improves. We object to tariffs that apply to goods imported from countries with which we have balanced trade.

As we argue in our book, Trading Away Our Future (Ideal Taxes Assn, 2008), the purchase of U.S. bonds and certificates of deposit by China and others enjoying a trade surplus with the U.S., put downward pressure on interest rates and fed the housing boom. Did it cause the bust? No, the Fed under Greenspan and Bernanke, and Fannie Mae and Freddie Mac took no action such as requiring larger down payments or raising interest rates.  The U.S. also continued the exemption of foreigners and foreign governments from taxation on interest from bank deposits and certificates of deposits which had been enacted when Don Regan was Pres. Reagan’s Secretary of the Treasury. Prof. Williams is right that U.S. economic policies contributed to the trade deficits. Economists can do little but recommend balancing the budget and maintaining a sound monetary policy. We can do something about the trade deficit. All we have to do is to recognize that many of our trading partners have been sursuing “beggar the U.S.” policies and all we need to do is get trade balanced. Our invention, scaled tariffs, would do that.

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Comment by Kim, 11/13/2010:

Didn't Friedman say that free trade wouldn't cost jobs (total number) because other countries would eventually need to use their US dollars to buy things that we made?

Response to this comment by Raymond L. Richman, 11/13/2010:
It is true that when a country has full employment, which economic theorists often assume, a trade deficit does not cause unemployment. Friedman was one of those and believed that those who lose their jobs find jobs producing other goods.  But Friedman overlooked the fact that those who lose their jobs as a result of trade deficits are likely to have to accept lower wages to find employment. So among the effects of the chronic deficits of the past two decades has been a worsening of the distribution of income. Economists tend to blame lack of skills as though workers engaged in manufacturing abroad have greater skills than our workers. Friedman also believed that free market forces cause trade deficits to be short-lived. No economist challenged that belief until Ben BVernanke when he was at the Council of Economic Advisors concluded that they won't get corrected as long as foreigners and their governments keep sending their savings (including trade surpluses) to the U.S. As you probably know, most of our government debt is owned by foreign governments. All this is in our book, Trading Away Our Future (Ideal Taxes Assn., 2008). 

Comment by Scott, 11/18/2010:

In your opinion: What role has worker productivity and automation played in increased unemployment rates in the U.S.?  And since Tariff's seem like a non starter politically, where will the U.S. innovation to create jobs come from? 

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]